An Earnings Season Scorecard Update

Takeaway:When corporate profits decline for two consecutive quarters or more the S&P 500 declines by at least 20%.

Its that time of year again.

Earnings season is upon us and, by just about every estimation, companies are due to report lackluster results on the top and bottom line.

Here's what you need to know via our Macro team in a note sent to subscribers earlier this morning:

"With 39 S&P 500 companies having reported Q1 earnings to date, sales growth is down -1.1% year-over-year and earnings growth has slowed to -11.8% year-over-year -- which would be the worst annual growth rate of the cycle if it holds through the rest of reporting season. Declines are being led by Materials (-34%), Tech (-20%) and Financials (-17%).

Compounding matters is the 25-30% spread between pro forma and GAAP, which continues to be reflected in a rising economy-wide debt-to-free-cash-flow ratio. Specifically, that ratio just reached 4x in 4Q15, which is the threshold it breached in 3Q07 on its way to peaking at 4.6x in mid-2008. We reiterate our view that neither the corporate profit nor credit cycles have seen their respective depths."

REMINDER

If the current earnings data holds, this would be the third quarter of contracting corporate profits.

WHY IT MATTERS

Our Macro team continues to highlight that when corporate profits decline for two consecutive quarters or more the S&P 500 declines by at least 20%.

Click chart below to enlarge

Performance? Where We're at...

In spite of truly ugly S&P 500 earnings in the last couple quarters, equities have rallied significantly off the February lows. However, this doesn't change our market views. We remain steadfastly bearish. Even with the recent pop, our favorite sector longs (Utilities, XLU) & shorts (Financials, XLF) continue to outperform. Here's the year-to-date scorecard:

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM

Takeaway:Even with poor U.S. economic data and profits sliding at domestic moneycenter banks, investors remained an optimistic bunch last week.

Key Takeaway:

The reflationary bounce that took hold February 12th persists, in spite of generally weak economic data from the U.S. and profit pressures at J.P. Morgan, Bank of America, and Wells. Bank CDS tightened globally, while the YTM on high yield fell -33 bps to 7.60%.

Our heatmap below is positive on the short term, negative on the intermediate, and mixed on long-term readings.

2. European Financial CDS – Swaps mostly tightened in Europe as investors clung to optimism last week. The median spread tightened by -14 bps to 121.

3. Asian Financial CDS – Swaps tightened nearly across the board in Asia last week. IDB Bank of India was the only one to widen, by 4 bps to 229. Even Chinese swaps tightened, where data released last week showed 1Q16 economic growth slowing to 6.7%, the slowest quarterly growth since 2009.

4. Sovereign CDS – Sovereign swaps mostly tightened over last week. Italian and Spanish swaps tightened the most, by -7 bps to 129 and by -7 bps to 93 respectively.

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 10 bps.

14. 2-10 Spread – Last week the 2-10 spread was unchanged at 102 bps. We track the 2-10 spread as an indicator of bank margin pressure.

15. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread was unchanged at 41 bps.

Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT

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04/18/16 08:53 AM EDT

CHART OF THE DAY: A Look At U.S. Oil Production Since 1861

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to learn more.

"... In the Chart of the Day today, we look at U.S. oil production going back to 1861. As the chart shows, 1970 has been, so far, the peak in domestic oil production at ~9.6 million barrels per day. Interestingly, 2015 was a close second with a production rate of some ~9.4 million barrels per day. Clearly, if prices had not started to decline in 2015, drilling and investment would have stayed at high levels and production grown beyond Hubbert’s peak in 2016."

From Peak to Peak

Just ask anybody, there is no shortage of the oil in the world. Or at least that’s the consensus view these days. In the short run, this is clearly correct. But what about in the longer term, say 5 or 10 years down the road?

We’ve been recently reacquainting ourselves with the work of M. King Hubbert and are in the middle of reading, “The Oracle of Oil”, by Mason Inman. Hubbert, as many of you know, is the geologist known for popularizing the idea of peak oil in the United States. He predicted that for any given geographical area, the rate of petroleum production of the reserve over time would resemble a bell curve.

Based on this theory, Hubbert presented a paper to the 1956 meeting of the American Petroleum Institute in San Antonio, Texas, which predicted that overall petroleum production would peak in the United States between 1965, which he considered most likely, and 1970, which he considered an upper-bound case. While his analysis was originally widely discredited, when domestic oil production actually peaked in 1970 Hubbert was very much validated.

In the Chart of the Day today, we look at U.S. oil production going back to 1861. As the chart shows, 1970 has been, so far, the peak in domestic oil production at ~9.6 million barrels per day. Interestingly, 2015 was a closed second with a production rate of some ~9.4 million barrels per day. Clearly, if prices had not started to decline in 2015, drilling and investment would have stayed at high levels and production grown beyond Hubbert’s peak in 2016.

But as it is, production in the United States is on the decline and, as of the most recent weekly data from the EIA, is down about 4.0% year-over-year. Despite this decline, which is largely due to somewhat tepid demand, inventory in the U.S. remains at record levels and is up 10.9%+ year-over-year. Eventually, though, declining production will begin to draw down this inventory.

At that point, investors in energy will likely get all bulled up on the price of oil. In reality, if the last couple of years have taught investors anything, it’s that there is no shortage of supply. And as for Hubbert’s Peak, at least on a strictly linear basis, the peak will likely be blown through in the next cycle of investment in domestic oil production with just a little bit of “Drill baby, drill!”

Back to the Global Macro Grind …

In the shorter term, oil, and really markets globally, are being roiled this morning because OPEC could not agree on production cuts. This fact seems to have shocked almost everyone except our policy team led by former Secretary of Energy Spencer Abraham and former Vice Chairman of the IEA Joe McMonigle who wrote the following last night:

“Since the production freeze proposal was first introduced in February, we have repeated our view in subsequent client notes that "a freeze is not a freeze without Iran." It now seems our mantra is also the official Saudi position from Doha.

Over a dozen oil producers from OPEC and Russia met in Qatar on Sunday to discuss a potential agreement to freeze production at January levels. While Iran made it clear it would not participate in the freeze as it ramps up post-sanctions production, many freeze proponents pushed for an agreement that excluded Iran as a way to support a "positive trend" in oil prices.

But as we pointed out in our Friday preview note on the freeze meeting, "the Saudi's would only support a freeze if all other producers agreed to participate, including and most especially Iran." Based on our analysis, we concluded in our Friday note that "there is no chance Saudi Arabia reverses its position and agrees to freeze production on Sunday."

The deal was dead Saturday morning Riyadh time when Saudi Deputy Crown Prince Mohammad Bin Salman reiterated his position in an interview from King Salman's private desert ranch that the Kingdom would not freeze production without Iran.

So oil ministers left Doha without reaching any agreement creating almost certain downward pressure on oil prices when the market opens on Monday. Oil was already down last Friday as pessimism grew about achieving an agreement in Doha. Any sell off Monday is now about the realization that there will be no agreement at the June 2 OPEC meeting either. The freeze is not a bridge to any future agreement.”

According to the CFTC, longs were adding to their positions into this weekend and long positions were peaking near a 9-month high. As a result, the sell off this morning is not entirely shocking.

Speaking of peaks, or lack thereof, there are a few more to highlight this morning:

Chinese housing prices clearly have NOT peaked with new home prices up +4.9% year-over-year and increasing in 62 cities;

U.S. corporate profit margins may have peaked, according to a report from Bloomberg this morning, which shows corporate profits their highest levels in 2014, at 9.7%, and are now closer to 9.0%;

The NABE highlighted a similar peak this morning with its survey that showed for the first time since the Great Recession more business owners are highlighting declining profits than expanding profits;

Spanish growth rates may have peaked, as both the IMF and Spanish cut government growth rate forecasts for the first time since 2013; and

In the global currency markets, the Japanese Yen clearly has not peaked breaking to new 19 month highs this morning as the Nikkei suffers its second -3% daily loss.

The bigger question of course is whether U.S. equities have peaked. In our models, U.S. equities remain in a bearish formation and, all else being equal, we have a hard time seeing them make a move towards a new peak with profit margins in decline. After all, there has only been one time since 1973 when profit margins narrowing by 60 or more basis points didn’t precede a recession.

So . . . Peaking late cycle anyone?

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.67-1.81%

SPX 2041-2091

Nikkei 15160-17065

VIX 13.03-18.72 USD 93.90-95.45

Gold 1210--1266

Keep your head up and stick to the ice,

Daryl G. Jones

Director of Research

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04/18/16 08:09 AM EDT

The Macro Show Replay with Energy Analyst Joe McMonigle | April 18, 2016

Birds-Eye View: Key Call-Outs (AGU, CF, MON)

We presented the bear case on Agrium last Wednesday at 11:00 a.m. with a blackbook and conference call. To summarize, we believe the retail business is misunderstood and subject to short-termism from an analysis perspective. In our view operating margins in the retail business, which have been stable post-recession, will contract meaningfully as the sector continues its long cyclical downturn. Ping us back directly for the deck or related inquiry.

Aside from our core thesis, below we outline some important catalysts to watch from a global trade perspective that will have implications for the competitiveness and profitability of U.S. farmers:

EM FX Move: After a sharp EM currency move for the Brazilian Real and Argentine Peso, the currencies of the two largest soybean exporting countries have appreciated meaningfully against the USD since Jan-Feb lows, which should have implications for the profitability and competiveness of Argentine exports as they are now selling a record stockpile onto global markets in volumes not seen since 2012. Robust Chinese demand and a bout of rainy weather in Argentina is also helping support prices and bullish speculation on the CME.

Brazil Factor: In Brazil, there is speculation on the direction of monetary policy and currency in particular should Rouseff be ousted (speculation for more hawkish policy from a new regime). With the lower house of congress voting to move forward with impeachment proceedings over the weekend, this appears more likely. Forward sales of commodities are reportedly being curbed significantly, and for soybeans specifically, this could shift some incremental buying to U.S. Markets: LINK

Long Bias in Soybeans: Aggregating net futures and options positioning from the CFTC shows a soybean market leaning +2.4x and +1.9x on a 6-mth and TTM z-score basis.

Fertilizer Rates: With muted application rates in the fall window, fertilizer prices and regional spreads have moved higher off the Jan. lows (urea and ammonia), with a jump in the Cornbelt/NOLA ammonia spread. Although volumes should come in strong Y/Y given the muted fall application season, prices are still down considerably Y/Y. As the last chart shows, we believe there is quite a bit of margin to lose on pricing after an unprecedented increase in money spent on crop input expenditures over the last several years.

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